By Choo Oi Yee, Chief Commercial Officer of iSTOX
Watching the public capital markets over the last seven weeks has felt a bit like watching a car accident unfolding in front of you — it’s horrific but you cannot look away. The Straits Times Index (STI) and the US indices (namely Dow Jones Industrial Average (DJI) and the S&P 500 (S&P)) fell more than 30% since the last week of February. And, while markets have since recovered somewhat, global sentiment remain extremely nervous.
Given the rather dismal current state of things, where can investors turn? Where may opportunities — if there are any right now — still be found?
A wise writer once said that while history doesn’t repeat itself, it does rhyme. In this spirit, let us take a closer look at the SARS epidemic from 2002 and 2004 and the Global Financial Crisis from 2008 to 2010 for insights.
Looking Back To Look Forward
The SARS crisis happened as the global economy was coming out of the dot-com bubble. Similar to COVID-19, the SARS outbreak began in China near the end of the year (in this case November of 2002) and quickly spread to other parts of Asia. Unlike COVID-19, SARS was largely contained in Asia, and, as we now know, was not nearly as contagious or destabilising as COVID-19. The STI slid more than 10% but recovered to close to pre-outbreak levels by May 2003. The Global Financial Crisis, triggered by the bankruptcy of Lehman Brothers and the nationalisation Fannie Mae and Freddie Mac in September 2008, had even deeper economic consequences. The crisis saw a more than 50% drop on the DJI over six months. While most major markets recovered to pre-crisis levels by end of 2009, the US took longer to recover, given systemic shocks to its financial system.
The long-term economic impact of COVID-19 remains unknown, but it already seems clear that it will far exceed the impact of the SARS epidemic and, quite possibly, the Global Financial Crisis as well. Governments have rapidly put together large economic stimulus packages in response. The US, for example, announced a US$2 trillion package (compared to US$787 billion during the Global Financial Crisis), buoying markets somewhat and stemming at least some of the haemorrhaging for now. Even so, until a vaccine is found and the social distancing measures are safely rolled back, the road ahead is likely to be a rough one. I believe that the next two quarters of reporting seasons will be crucial to fully understanding the scope of the economic damage caused by COVID-19.
In times of such of volatility and uncertainty, many investors have been feeling the pain of margin calls and seeing their portfolio values diminish. Others, who have cash on the sidelines, are actively looking for under-priced securities and opportunities in the public markets. Aside from these sorts of tactical moves, however, what other asset classes and opportunities are there to consider for those that want to enhance their portfolio’s risk-reward profile?
It is here that we return to SARS epidemic and the Global Financial Crisis. In both crises, investment portfolios that included private market investments (also called alternative investments) often out-performed purely public market exposure in terms of both return and risk. These private market instruments include investments like hedge funds, private equity, real estate and infrastructure.
A PGIM Institutional Advisory & Solutions study of risk-return of asset subcategories from January 2000 to March 2015, for example, showed that the S&P 500 had a return of 4% versus approximately 15% risk. In comparison, a global macro hedge fund over the same period might return close to 6% with a far lower risk profile. For a similar risk profile to the S&P 500, one could have invested in opportunistic real estate, which returned more than 8%.
Long-Term Trend: Institutional And Ultra High Net Worth Capital Flowing To Private Markets
The growing attractiveness of these alternative investments have not been lost on big institutional investors. They have increasingly looked to private market alternatives to diversify their portfolios due to their low correlation to the public markets, allowing them to mitigate stock market volatility and potentially earn higher returns.
Indeed, private capital fundraising amounts have grown significantly in the last decade, with institutional capital leading the way. According to a 2018 PwC study, sovereign wealth funds are already allocating more than 20% of their portfolio into alternatives and are diversifying their portfolios to include alternative investments to enhance returns. In addition, another study found that pension fund’s allocation to alternatives rose from 6% in 1999 to 23% in 2019.
These institutional investors are not alone. Ultra-high net worth investors — those with investable assets of at least $30 million — have also jumped onto the bandwagon. In a Global Family Office study conducted by UBS, over 40% of the portfolios of the family offices surveyed were already invested in alternatives.
Then And Now: One Key Difference
Even before the rise of COVID-19, alternative investments as an asset class seemed well poised for continued growth among institutional and ultra-high net worth investors. Given their track record across the SARS epidemic and the Global Financial Crisis, it seems quite possible to me that this trend will actually accelerate during the current pandemic.
There is at least one key difference this time around, however — specifically, who else has access to private market investments.
The current model of private capital markets is not at all suited for even ‘average’ high net worth investors — those with a net worth of between S$1 million and S$5 million. Long lock-up periods (often more than three years), illiquid underlying investments, higher risk strategies, higher leverage and large minimum investment sizes have all played a role in effectively locking out all but the most wealthy and well-connected players from fully accessing alternatives. Due to a variety of factors, conventional fund managers, investment banks and others who bridge the gap between issuer and investor have been unable to reform the system.
This, however, is starting to change. New innovations such as cloud technology, smart contracts and digitised securities are making it possible to greatly lower costs and expand access to alternatives, opening the private capital market to the growing number of investors that the continuous rise of income level across Asia has created.
The COVID-19 pandemic has disrupted the global economy, massively shifted employment patterns to a work-from-home model and forced many businesses to move completely online or close. Technology has been the key to facilitating all of these changes. In the same vein, technology is enabling — and accelerating — the democratisation of alternative and private capital market investments.
It will truly be fascinating to look back at this moment in history from five to ten years in the future, just as we are now doing with SARS epidemic and the Global Financial Crisis.